By Adam Cmejla,
President of Integrated Planning & Wealth Management, LLC
Dec. 23, 2015
You have many options for retirement from your practice. Here are your main options, including the pros and cons of each.
DECIDE BETWEEN QUALIFIED PLAN OR IRA. Consider needed contribution levels by practice owner and loan provisions, among other factors.
CONSIDER AGE & TENURE OF EMPLOYEES. When evaluating the amounts contributed to each team member’s account, “age weighted” and “target benefit” plans will take into consideration the age of the entire team, not just the owners.
GAUGE CASH FLOW OF PRACTICE. A practice with significant net profit and free cash flow allows the practice to match employee contributions and for the employees to shelter those profits within their own retirement accounts within the practice.
Practice ownership offers great opportunities to increase your net worth and reach a point of financial independence for retirement. Implementing a retirement plan in your practice is one of the first steps to reaching financial independence, while also helping your employees in their financial planning. Here are some of your retirement planning options, and how to determine which is the best fit for your practice.
If you don’t already have a retirement plan in place, it may not be too late to do so for 2015, depending on the type of plan you choose. You may still be able to take advantage of some last-minute tax planning to help offset any potential taxes that may come due in April 2016.
Qualified Plan or IRA Plan
First, you will need to determine whether you will implement a qualified plan or an IRA based plan. A “qualified plan” is not descriptive of the tax implications, but rather, whether the plan is subject to ERISA guidelines. A 401(k) (Safe Harbor or otherwise), Profit Sharing Plan, Cash Balance, Target Benefit, Defined Benefit, or ESOP plans are all examples of qualified plans. On the other side of the coin, the SEP and SIMPLE are examples of IRA-based retirement plans.
While there are two different types of plans, please be aware that they both have tax advantages that can be beneficial to both the business owner and team members. The extent of those benefits, and when those benefits are realized, is dependent around the type of plan, design, and implementation.
The following are some benefits and exchanges to consider when looking at a qualified plan vs IRA plan:
Variables to Consider
When evaluating the type of retirement plan to implement into your practice, there are a number of key variables to be cognizant of in the decision making process. Some of those variables include:
Age of your team. It’s not just the age of the owner that indicates the total funding requirements of a retirement plan. The age of your team members could impact the amount that the plan/employer may be required to contribute. “Age weighted” and “target benefit” plans will take into consideration the age of the entire team, not just the owners. The older the team member, the higher the amount that is typically required to be contributed.
Tenure and age of your team. If you are a practice that has struggled to retain top talent, a top-notch retirement plan may be one of the ways in which you can encourage them to stick around. According to a Glassdoor.com Employment Confidence survey, 31 percent of team members would value a 401k or other retirement plan above pay raises. Contrary to popular belief, more and more people are becoming aware that retirement planning and saving for the future is their own responsibility. In addition, the age of your team can also influence how much will need to be contributed to specific plans. (See profit sharing 401k example below).
Needs of your family. If your family is involved in the business, there are additional considerations that must be met. Based on their relationship to the primary business owner, most immediate family members will be considered a “highly compensated employee,” which means there are additional testing requirements that must be met and satisfied for certain types of qualified plans. SEP and SIMPLE plans do not follow these requirements.
Employing family members in your practice, especially the next generation (children, grandchildren), is a tactical and beneficial approach to succession planning, wealth transfer and generational gifting strategies.
Cash flow of the practice. A practice with significant net profit and free cash flow better equips the doctor to make not only employee match contributions, but also to shelter those profits within their own retirement accounts within the practice. This important factor will influence where and how much can be contributed to the owner’s accounts.
For example, if we have a 52-year-old doctor whose W-2 salary is $125,000 and the practice has operating income of $400,000 (Line 21 of Form 1120S of business tax return), let’s look at what total contributions could be implemented when looking at a profit sharing safe harbor 401(k) versus a SIMPLE IRA:
Two Key Decisions
In the example below, is the Employee Deferral is for the owner of the business. It shows how the owner-doctor of the practice benefits more from a 410k than from an IRA.
**Profit sharing contributions are limited to the IRS Section 415 max amount of $53,000 for 2015. It’s important to realize that profit sharing contributions in a qualified plan are subject to testing requirements as required by ERISA guidelines and will require profit sharing contributions to employees’ accounts, as well. This is typically the area of plan design that has the most impact for the business owner and can influence what specific strategy is used based off of the cash flow of the practice, the owner’s intentions, and age and salary of the practice’s staff.
What plan might work for you? As you can see, there are many options to decide among when implementing a retirement plan for your practice, and multiple factors that influence plan design. It’s important to understand your roles and responsibilities as a business owner when implementing a retirement plan, and to be confident that you’re working with a qualified, competent advisory team that understands the financial implications of your business model and profession.
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Adam Cmejla, CFP®, CMFC®, is a Certified Financial Plannertm and president of Integrated Planning & Wealth Management, LLC, a financial planning and investment management firm that works with optometrists.For more information: Contact Adam at 317-853-6777 or firstname.lastname@example.org.